In this video, we walk through 5 BAR practice questions on fund balance classification for governmental capital assets. These questions are from BAR content area 3 on the AICPA CPA exam blueprints: State and Local Governments.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Governmental Capital Assets
Capital assets are long-term assets used by a state or local government to provide services. In the government-wide financial statements, these assets are reported because those statements use the economic resources measurement focus. That means the statements include long-term assets and long-term liabilities, not just current financial resources.
This is different from governmental fund financial statements. In governmental funds, a capital asset purchase is usually reported as an expenditure. In the government-wide statements, the asset itself is reported as a capital asset and depreciated if applicable.
Identifying Capital Assets
Governmental capital assets may include land, buildings, improvements, machinery, equipment, infrastructure, construction in progress, and right-to-use lease assets. Land, buildings, vehicles, and equipment are usually easy to recognize.
Infrastructure is a government-specific category that includes long-lived public assets such as roads, bridges, tunnels, drainage systems, sidewalks, water systems, and sewer systems. Right-to-use lease assets arise when a government has the right to use another party’s asset under a lease, such as leased office space, vehicles, or equipment.
Initial Measurement
Purchased capital assets are recorded at historical cost. Historical cost includes the purchase price plus costs necessary to place the asset into service. For example, if a government buys machinery and also pays freight and installation costs, those costs are included in the capitalized cost of the machinery.
The basic rule is that costs needed to get the asset ready for use are capitalized. Ordinary repairs and maintenance are generally expensed.
Donated capital assets are recorded at acquisition value at the date of donation. A donated asset is not recorded at zero just because the government did not pay cash for it. For example, if land is donated to a county and the land has an acquisition value of $265,000 at the date of donation, the county records the land at $265,000.
Depreciation
For most governmental capital assets, depreciation works the same way it does for a business. The government takes the asset’s cost, subtracts any estimated residual value, and depreciates the remaining amount over the asset’s estimated useful life.
For example, assume equipment costs $300,000, has a residual value of $20,000, and has a useful life of 7 years. The depreciable cost is $280,000. Using straight-line depreciation, annual depreciation is $40,000.
The government-wide journal entry would be:
Dr. Depreciation expense $40,000
Cr. Accumulated depreciation $40,000
The main point is that depreciation is not automatically unusual just because the entity is a government. Unless a special rule applies, it is calculated normally.
Some assets are not depreciated. Land is not depreciated because it does not have a limited useful life. Construction in progress is not depreciated while the asset is still being constructed. Right-to-use lease assets are usually amortized rather than depreciated, but the idea is similar: the cost is allocated over the period benefited.
Modified Approach for Infrastructure
The modified approach is one of the main exceptions to normal depreciation. It applies to certain infrastructure assets, such as roads, bridges, tunnels, and drainage systems.
If a government uses the modified approach, it does not depreciate the qualifying infrastructure asset. Instead, the government expenses the costs incurred to preserve and maintain the asset. The infrastructure is still reported as a capital asset in the government-wide financial statements.
To use the modified approach, the government must have an asset management system. This includes an inventory of the infrastructure assets, condition assessments, and estimates of the annual amount needed to preserve the assets. The government must also document that the infrastructure is being maintained at or above the condition level it established.
Net Capital Assets
Net capital assets are calculated by taking capital asset balances and subtracting accumulated depreciation or accumulated amortization. Buildings and equipment are reported net of accumulated depreciation. Right-to-use lease assets are reported net of accumulated amortization.
Land, construction in progress, and infrastructure reported using the modified approach are not reduced by depreciation. Land is not depreciated, construction in progress has not yet been placed into service, and qualifying infrastructure under the modified approach is preserved rather than depreciated.
Historical Treasures and Works of Art
Works of art, historical treasures, and similar assets are generally capital assets, but collections have special rules. A government may choose not to capitalize a collection if it is held for public exhibition, education, or research rather than financial gain, is protected and preserved, and has a policy requiring proceeds from sales of collection items to be used to acquire other collection items.
If a work of art or historical treasure is capitalized and is considered inexhaustible, depreciation is not required. This is because its service potential is not used up in the same way as a normal depreciable asset.
Bottom Line
Governmental capital asset accounting is mostly normal capital asset accounting. Most assets are recorded at cost, depreciated over their useful lives, and reported net of accumulated depreciation or amortization.
The main special areas to remember are donated assets, the modified approach for infrastructure, and collections of historical treasures or works of art.
